As “Bad-Boy” Recourse Liability Spreads to Construction Lenders . . . Is the End Near for Non-Recourse Liability??

Once upon a time and in a very simple time, construction lenders required full payment and performance guarantees, and only permanent lenders offered non-recourse financing (with “bad-boy” liability). Now, even some construction lenders include a variation of non-recourse liability (with “bad-boy” events) in their structure. And, the list of “triggers” or events that form the basis for liability is growing. If this trend continues –

will the number or bundle of “bad-boy” events be substantial enough to constitute, in a practical sense, the “end” of the non-recourse loan structure?

The time-line seems to say “yes.”

Traditionally, permanent lenders (typically life insurance companies) were the only commercial real estate lenders who incorporated the concept of “non-recourse” liability into their lending product. In the structure, neither the borrower nor the guarantor (or indemnitor) was liable for the repayment of the loan. If the project or local market went bad, the lender could obtain title to the property, but could not sue them for recovery of the balance of the loan.

Importantly, the triggers or events for liability were few in number: maybe 6 or 8.

Back in the day, life and liability was simple:

construction loan (high risk period since tenants were not paying rent): 100% liability

permanent loan (once tenants paying rent, then risk much lower): short list of bad-boy events as the only basis for liability

However, securitization of commercial real estate loans (CMBS) and the recent “down turn” of the economy introduced a much larger set of bad-boy events (Courtney Bristow’s article on dealing with distressed CMBS loans gives a nice over view – it is the #1 download from L360 [and the former TT4L blog]).

I’m confident that the list of bad-boy liability events will continue to grow. For example, technology issues alone will father more bad-boy events. (Take a look at my other posts.)

The non-recourse (bad-boy) liability structure is becoming form over substance.

If you view this differently, or want to give me a course correction, please comment below.

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Lenders 360 provides news, information and commentary on important issues affecting the financial services industry. Written by leading attorneys who serve startup to mature financial institutions and loan servicers, the Lenders 360 blog is designed to help companies stay current on business and legal issues, covering every business cycle, including the “good times” and "bad times.”